What happens to your business if your business partner/shareholder goes?

In the insurance industry we call it ‘Being Carried Out’ as opposed to ‘Walking Out’ of the business. We’ve previously talked about mitigating the business risks if something happens to you, but what if it’s your business partner?

Liz and Craig own a successful company together. The business was started by Liz and a few years ago Craig bought a 25% shareholding. Over the past couple of years he increased his shareholding to 50%.  The business has a current value agreed at $4,000,000, meaning their shareholdings are $2,000,000 each.  They both work full-time in the business, are equally important to creating sales revenue, and earn salaries of $200,000pa along with company cars and a profit share.  They are both also sole income earners within their families, each supporting their spouse and kids.  

One regular Tuesday afternoon Liz leaves the office as usual with a quick goodbye to Craig, her friend and business partner of many years. It is the last time Craig will see her. That night Liz has a massive stroke and passes away.

Both Liz’s family and Craig suffer huge shock and grief from the untimely passing of a beloved mother and friend. In addition to the emotional storm Craig and Liz’s husband now find themselves thrust into responsibility for the business together, with Liz’s family lawyer as a third party. For Liz’s husband, it is a scenario he never imagined or wanted and he wants to exit as quickly as possible. 

At the first meeting, the family lawyer requests Liz’s shares in the business to be paid out with urgency and in the interim to ensure no change to Liz’s $200,000 salary on which the family depends.

Craig has lost a friend and a partner who had intellectual and personal qualities that he relied upon. With the pressing need to find $2,000,000 to buy Liz’s shares and to continue to pay her salary, Craig will have little time to process his grief or consider how those qualities can be replaced. From the bank’s perspective the business has just lost a significant income generator and is looking a lot shakier than it did a week ago so it is very doubtful he can even secure a loan to fund the share purchase.  

In this case there was help on the horizon. Craig and Liz had commenced a Shareholder Protection Plan a few years before. A claim was made on this plan and $2,000,000 was paid to Liz’s spouse and the shares were transferred to Craig.

The outcome? - the business was secured for Craig and his family, a pay-out was made that gave financial certainty to Liz’s family, and Liz’s spouse was relieved of the strain of the business.

It helped that Liz and Craig had met with their advisor and reviewed this cover annually.  They had made adjustments to cover the increases in Craig’s shareholding and had an agreed valuation formula in place, so that when the time came the insurance cover correctly reflected the value of the shares. 

Shareholder Protection Cover allows for the smooth transition of ownership in the event of the death or permanent disablement of a shareholder; it is simply put, a funding mechanism that enables the purchase of their shares.  An important part of this plan is creating a binding Buy/Sell agreement.  This means that in the event of a claim the insurance funds have to be used to purchase the shares from the exited shareholder/estate and the estate of the exited shareholder has to sell these to the remaining shareholder. 

This cover is particularly relevant for businesses with two or more owners. It protects the Family/Estate of the exited shareholder who receives fair value for their shares, the remaining shareholder/shareholders who gain full ownership, but also the security of the business itself by creating a stable footing for the remaining shareholders, staff and other stakeholders to recover and rebuild.

Liz and Craig had also put in place Key Person Cover on themselves so the financial strain on Craig was eased and he could continue running the business and pay for recruiting and training a new employee.

Once again, even if you have this cover in place, have you reviewed it recently? It needs to be reviewed annually, to make sure the levels are relevant and accurately reflect shareholdings and business’ value.

If you would like to meet and discuss your situation I am happy to help.